Testing to destruction

Reverse stress testing is set to become standard practice under Solvency II as part of the validation process for internal models, yet for most European insurers such tests are a new concept. Clive Davidson examines what can be learned from the UK, where the Financial Services Authority has been pioneering this technique as part of its risk-based capital regime

The UK’s Financial Services Authority (FSA) requires insurers to look disaster in the eye and examine how prepared they are to avoid it. Called reverse stress testing, the idea is to bring the nightmares that might keep senior executives awake at night into the cold light of day and look at what steps insurers could take to survive should the dark dreams become a reality.

“We want to understand what firms think about potential weaknesses in their business models and, in particular, how they are